Brighter European economic prospects overshadowed

Negative aspects will outweigh brighter European economic prospects

by David Marsh

Thu 22 Jan 2015

Whatever the exact nature of the European Central Bank’s quantitative easing programme decided today in Frankfurt, the ECB has firmly crossed a fateful line into the world of full-scale politicisation, the opposite of what its purist proponents wanted.

Contrasting statements on the desirability of significant QE by German Chancellor Angela Merkel, President François Hollande of France and Matteo Renzi, the Italian prime minister, as well as the anti-QE vote by the Dutch parliament, underline Europe’s polarisation between debtors and creditors, countermanding the integrative spirit behind monetary union’s birth 15 years ago.

Amid expectations that the ECB will announce a €50bn a month bond-buying programme to fulfil its €1tn two-year balance sheet expansion aim, Europe’s monetary policy-makers are likely to end up spurring high-profile disappointment among both supporters and denigrators of aggressive easing policies. Irrespective of the outcome, the euro is likely to decline in coming weeks as policy disarray, uncertainties after the weekend Greek election and a groundswell towards negative interest rates across European bond markets hits buying sentiment for the single currency.

Although anti-euro parties are becoming popular across Europe, the continent could be poised for a better few years economically, as a result of abundant liquidity, low interest rates, continued growth in Germany and core countries, a reinforced banking system, the weak euro and low oil prices. Unfortunately, in coming months this relatively favourable background will not command much attention in politics and public opinion and is unlikely to become a dominant factor on markets.

Displeasure will prevail. Restrictions on risk-sharing to appease anti-QE feeling in the creditor countries will not go far enough to counter suspicions that the ECB is ushering in stealthy fiscal transfers between financially orthodox northern states and the heavily indebted south. Business people and politicians in Germany and elsewhere will complain that the ECB is lowering pressures on governments to buttress growth through economic restructuring.

A probable Bundesbank agreement to take up its share of monthly bond-purchase quotas and swallow objections to purchasing bonds at negative interest rates will promote a further outcry from German politicians and the media.

Yet these constraints will infuriate proponents of mutual solidarity within the euro bloc, inflame criticism that it is run on unduly Germanic lines, and dilute what Mario Draghi, the ECB president, has called the ‘singleness’ of euro monetary policy. Exclusion of Greece from the main QE measures will inflame the belief in Athens that mainstream Europe is driving a wedge between Greece and the other euro adherents and even preparing a divorce.

Fault lines within monetary union have been evident from the beginning, between French-led supporters of an ECB subservient to governmental will and the Germanic concept of an independent Bundesbank-like construct as the arbiter rather than the servant of politics. These divisions were covered up during the euro’s earlier more successful years, but – attested by lurid newspaper headlines and commentaries all over Europe – have now burst fully through to the surface.

The manifold controversies of the bond-buying programme are often hopelessly exaggerated. Yet ECB efforts to play down the measures’ negative aspects – for example, through a German media offensive to explain the ECB’s thinking, or politically brokered concessions over risk-sharing – have ended up by drawing attention to them. The actual size of ECB QE is relatively low compared with steps taken by the other internationally important central banks, the US Federal Reserve, the Bank of Japan and the Bank of England. As the chart shows, compared with the pre-crisis position of January 2008, the increase in the ECB’s balance sheet by late 2016 will still be only around half that implemented by the other big central banks. In terms of GDP, on present trends the ECB’s balance sheet in two years will be around 30% of GDP against 25% in the US and the UK and 60% in Japan.

Although increasingly vilified in Germany as representing the interests of profligate southern states, Draghi is actually a conservative treasury official and central banker who was relatively sceptical about the single currency 25 years ago and is well aware of the perils of lowering the barriers between fiscal and monetary policy. In his first press conference as ECB president, Draghi in November 2011 set his course firmly against becoming a lender of last resort for European governments. He said the way forward for countries facing economic problems was ‘not to count on external help that could alleviate the temporary market pressures. Instead the real answer is actually to count on the countries’ capacity to reform themselves with the right economic policies.’ This is a plea that Draghi has been repeating, with limited success, ever since.